risparmier
Forumer storico
Le misure necessarie per scongiurare la catastrofe e la decomposizione economica:
Global
Aggressive Policy Actions Will Avert Both Depression and Deflation
November 26, 2008
By Richard Berner | New York
In recent weeks, a policy vacuum in Washington and terrible economic news had increased the ‘tail’ risks of prolonged recession and deflation. Not surprisingly, comparisons between the current crisis and the Great Depression or Japan’s Lost Decade multiplied.
In our view, comparisons with those disasters are greatly exaggerated. To be sure, serious risks still point to a weaker economy, a longer downturn and the threat of deflation. And today’s sins of omission have been similar to the 1930s and the Lost Decade: Policy has yet to break the adverse feedback loop from the deleveraging of lenders’ balance sheets to the economy that is at the heart of this credit-crunch-induced recession. More importantly, however, those two earlier calamities also involved egregious sins of commission or at least delay. Tightening monetary and fiscal policy turned a serious recession into the Great Depression, and protectionism made it worse. Japanese authorities eventually embraced the right policies, including cleaning up bank balance sheets, but it took a decade to adopt them.
In contrast, we believe that the Obama Administration will implement aggressive policy actions that reflect the lessons of those two events. As we see it, three lessons for policymakers from the Depression and Japan stand out: First, aggressively use macro policies to buy time for other needed policies to be implemented and to take effect. Second, employ policies to stabilize the financial system and attack the roots of the credit crunch. Finally, adopt measures to reduce the imbalances, especially in housing, that triggered the downturn. Let’s examine them in turn.
First, macro policies must be forceful and appropriate to cushion the blow from the adverse feedback loops depressing markets and the economy and to avert deflation. How forceful? Consider that the free fall in global equity prices and the decline in home prices will have slashed household net worth by $11 trillion or nearly 20% over the course of 2008. Even if asset prices somehow stabilize by year-end, this unprecedented plunge in household wealth may prompt consumers to cut spending by a cumulative four percentage points next year and in coming years. Tighter lending standards for businesses, residential and commercial real estate, state and local governments and a weakening global economy seem likely to depress demand by roughly another 2 percentage points of GDP over the coming year. While the sharp slide in gasoline and other energy quotes will add back $250 billion or more (2-2.5%) to discretionary incomes, that still leaves a hole of roughly 3-4% of GDP ($425-575 billion) to fill. If no lame-duck plan is enacted (other than extending unemployment insurance benefits), then the incoming Obama Administration is right to consider a very substantial menu of fiscal stimulus including immediate, medium-term and longer-term elements (for details, see “The Obama Policy Mix”, Global Economic Forum, November 10, 2008).
Likewise, the “output gap” between actual and potential real GDP seems likely to rise to 5-6% of real production of goods and services – a level consistent in the past with declines in inflation of more than 2 percentage points. Given that underlying or “core” inflation measured by the CPI is now running just over 2%, the risks of deflation in that context are rising. Further aggressive steps for monetary policy to avert such an outcome are appropriate, but with the Federal funds rate at 1%, many perceive that the Fed is running out of ammunition.
In our view, nothing could be further from the truth. The Fed has already begun an aggressive plan of quantitative easing (QE) that has doubled the size of its balance sheet in two months. The problem, of course, is that banks are hoarding the resulting expansion of reserves. As a result, QE has had little impact on expansion of bank balance sheets or on the economy; in effect, the money multiplier (the ratio of monetary aggregates or bank liabilities to bank reserves) has collapsed (for details, see Revenge of the Ms, November 18, 2008).
But the Fed is not pushing on a string. Three additional policy options are available to realize the full potency of QE, ease financial conditions, and help revive securitization markets. First, the Fed can buy longer-term government securities or private sector securities such as mortgages. That would bring down longer-term yields and more importantly the wider risk spreads that are symptomatic of dysfunctional securitization markets and that have made financial conditions ever more restrictive. Second, the Fed can commit to keep the funds rate rates low. The FOMC used such a strategy in 2003-4, but then the commitment was unconditional or merely a function of the calendar; rates were kept low for “a considerable period”. A more refined strategy would make any such promise conditional on inflation performance. Such a pledge, like Japan’s in 2002-3, would prevent inflation expectations from falling below the point where deflation could become a self-fulfilling prophecy. Finally, the Fed can monetize the coming fiscal stimulus, keeping rates low despite significant actions that would boost the demand for credit and otherwise push rates up. These three options are actually all familiar to the FOMC, as they were discussed at length as early as the January 2002 FOMC meeting (see Board Staff Presentation on the Implications of the Zero Bound on Nominal Interest Rates, January 29, 2002). It appears that the Fed’s expansion of the December 16 FOMC meeting to two days rather than one is designed to weigh such a strategy and tactics.
While these aggressive macro policies are necessary to prevent a downward economic spiral, they are unlikely to be sufficient, because they do not get to the sources of the credit crunch; namely sliding asset values, erosion of capital at leveraged lenders, deleveraging of their balance sheets, and the economic imbalance between supply and demand in housing.
Indeed, we think three other sets of policies are needed to stop the rot and promote the basis for eventual recovery. First, officials should prosecute full implementation of steps to stabilize the financial system: 1) backstop liabilities and counterparty risk, 2) continue to increase funding, and 3) clean up balance sheets (for detailed recommendations see A Plan to Stabilize the Financial System, October 10, and Assessing the Plan to Stabilize the Financial System, October 15). The final rules in the FDIC’s Temporary Loan Guarantee program should begin to promote new issues of senior debt that will strengthen financial institutions’ balance sheets. The willingness to expand and possibly extend the Fed’s several lending and funding facilities and FX swap lines should continue to foster ample market liquidity. For example, officials are apparently considering a new ABS funding facility that would help to jump start the moribund ABS market for consumer loans.
Most important, using available funds to inject capital in exchange for preferred shares, and creating a mechanism – a “good-bank-bad bank” structure – to ring-fence some troubled assets would buy time to assess NPLs, promote appropriate writedowns, and encourage significant further consolidation in financial services. In turn, cleaning up balance sheets, as was ultimately done in Sweden in their 1992 banking crisis, in Japan, and in the US savings and loan crisis, will help slow the deleveraging process and ultimately is the only way to end the credit crunch. To quote my colleague Robert Feldman in drawing conclusions from the Japanese crisis: “Capital injections are a necessary but not sufficient condition to restore confidence in bank equity prices. Confidence needs to be restored in the value of the assets before stocks undergo a sustainable increase. This can only be achieved by removing bad assets from the balance sheets, without recourse.” I couldn't agree more. It is encouraging that the Fed and the Treasury are using such a structure – not just to help ailing Citigroup, but also to reduce systemic risk (see Betsy Graseck, Citigroup: Fed Action a Strong Positive; Less Loss and Dilution Risk, November 24, 2008).
The second needed set of policies includes aggressive implementation of steps to mitigate mortgage foreclosures. The rising tide of foreclosures adds to the inventory of vacant homes and to the real estate owned on lenders’ balance sheets, puts downward pressure on home prices, and creates significant economic hardship for the individuals, the lenders, and the communities involved. There are many obstacles. Not all foreclosures should or can be avoided; the goal is to reduce preventable foreclosures. Forbearance in some cases may simply delay default and encourage irresponsible behavior. The government can’t influence all mortgages, and making loan workouts work will cost some money. There is a risk that any remedy to fix a temporary crisis will become permanent. Given those obstacles, there are no good choices, but the least bad ones would be targeted, varied, and would share losses among borrowers, lenders and the taxpayer. The FDIC proposal, modeled after the protocol used for IndyMac Bank, shares the losses 50-50% between the lender and the agency in the event that modified loans re-default; the plan for Citigroup requires use of this plan. These measures will complement steps to clean up balance sheets and help troubled homeowners.
Finally, officials should seek policies to reduce the supply-demand imbalance in housing. Here there is debate over the most effective policy options. New tax subsidies, as proposed by Alan Meltzer, would increase housing demand, but they risk becoming permanent. And in the context of a serious credit crunch, they may not be sufficient to push up housing demand. It’s worth noting that the benefits for housing demand from lower mortgage interest rates and increased credit availability from steps 1 & 2 above should also help. In other words, these three steps should be implemented in concert as part of a complete package.
.... And my colleague Abhijit Chakrabortti notes that the S&P 500 dividend yield at 4% is 150 basis points above its long-term average.
...
http://www.morganstanley.com/views/gef/index.html#anchor7232
Global
Aggressive Policy Actions Will Avert Both Depression and Deflation
November 26, 2008
By Richard Berner | New York
In recent weeks, a policy vacuum in Washington and terrible economic news had increased the ‘tail’ risks of prolonged recession and deflation. Not surprisingly, comparisons between the current crisis and the Great Depression or Japan’s Lost Decade multiplied.
In our view, comparisons with those disasters are greatly exaggerated. To be sure, serious risks still point to a weaker economy, a longer downturn and the threat of deflation. And today’s sins of omission have been similar to the 1930s and the Lost Decade: Policy has yet to break the adverse feedback loop from the deleveraging of lenders’ balance sheets to the economy that is at the heart of this credit-crunch-induced recession. More importantly, however, those two earlier calamities also involved egregious sins of commission or at least delay. Tightening monetary and fiscal policy turned a serious recession into the Great Depression, and protectionism made it worse. Japanese authorities eventually embraced the right policies, including cleaning up bank balance sheets, but it took a decade to adopt them.
In contrast, we believe that the Obama Administration will implement aggressive policy actions that reflect the lessons of those two events. As we see it, three lessons for policymakers from the Depression and Japan stand out: First, aggressively use macro policies to buy time for other needed policies to be implemented and to take effect. Second, employ policies to stabilize the financial system and attack the roots of the credit crunch. Finally, adopt measures to reduce the imbalances, especially in housing, that triggered the downturn. Let’s examine them in turn.
First, macro policies must be forceful and appropriate to cushion the blow from the adverse feedback loops depressing markets and the economy and to avert deflation. How forceful? Consider that the free fall in global equity prices and the decline in home prices will have slashed household net worth by $11 trillion or nearly 20% over the course of 2008. Even if asset prices somehow stabilize by year-end, this unprecedented plunge in household wealth may prompt consumers to cut spending by a cumulative four percentage points next year and in coming years. Tighter lending standards for businesses, residential and commercial real estate, state and local governments and a weakening global economy seem likely to depress demand by roughly another 2 percentage points of GDP over the coming year. While the sharp slide in gasoline and other energy quotes will add back $250 billion or more (2-2.5%) to discretionary incomes, that still leaves a hole of roughly 3-4% of GDP ($425-575 billion) to fill. If no lame-duck plan is enacted (other than extending unemployment insurance benefits), then the incoming Obama Administration is right to consider a very substantial menu of fiscal stimulus including immediate, medium-term and longer-term elements (for details, see “The Obama Policy Mix”, Global Economic Forum, November 10, 2008).
Likewise, the “output gap” between actual and potential real GDP seems likely to rise to 5-6% of real production of goods and services – a level consistent in the past with declines in inflation of more than 2 percentage points. Given that underlying or “core” inflation measured by the CPI is now running just over 2%, the risks of deflation in that context are rising. Further aggressive steps for monetary policy to avert such an outcome are appropriate, but with the Federal funds rate at 1%, many perceive that the Fed is running out of ammunition.
In our view, nothing could be further from the truth. The Fed has already begun an aggressive plan of quantitative easing (QE) that has doubled the size of its balance sheet in two months. The problem, of course, is that banks are hoarding the resulting expansion of reserves. As a result, QE has had little impact on expansion of bank balance sheets or on the economy; in effect, the money multiplier (the ratio of monetary aggregates or bank liabilities to bank reserves) has collapsed (for details, see Revenge of the Ms, November 18, 2008).
But the Fed is not pushing on a string. Three additional policy options are available to realize the full potency of QE, ease financial conditions, and help revive securitization markets. First, the Fed can buy longer-term government securities or private sector securities such as mortgages. That would bring down longer-term yields and more importantly the wider risk spreads that are symptomatic of dysfunctional securitization markets and that have made financial conditions ever more restrictive. Second, the Fed can commit to keep the funds rate rates low. The FOMC used such a strategy in 2003-4, but then the commitment was unconditional or merely a function of the calendar; rates were kept low for “a considerable period”. A more refined strategy would make any such promise conditional on inflation performance. Such a pledge, like Japan’s in 2002-3, would prevent inflation expectations from falling below the point where deflation could become a self-fulfilling prophecy. Finally, the Fed can monetize the coming fiscal stimulus, keeping rates low despite significant actions that would boost the demand for credit and otherwise push rates up. These three options are actually all familiar to the FOMC, as they were discussed at length as early as the January 2002 FOMC meeting (see Board Staff Presentation on the Implications of the Zero Bound on Nominal Interest Rates, January 29, 2002). It appears that the Fed’s expansion of the December 16 FOMC meeting to two days rather than one is designed to weigh such a strategy and tactics.
While these aggressive macro policies are necessary to prevent a downward economic spiral, they are unlikely to be sufficient, because they do not get to the sources of the credit crunch; namely sliding asset values, erosion of capital at leveraged lenders, deleveraging of their balance sheets, and the economic imbalance between supply and demand in housing.
Indeed, we think three other sets of policies are needed to stop the rot and promote the basis for eventual recovery. First, officials should prosecute full implementation of steps to stabilize the financial system: 1) backstop liabilities and counterparty risk, 2) continue to increase funding, and 3) clean up balance sheets (for detailed recommendations see A Plan to Stabilize the Financial System, October 10, and Assessing the Plan to Stabilize the Financial System, October 15). The final rules in the FDIC’s Temporary Loan Guarantee program should begin to promote new issues of senior debt that will strengthen financial institutions’ balance sheets. The willingness to expand and possibly extend the Fed’s several lending and funding facilities and FX swap lines should continue to foster ample market liquidity. For example, officials are apparently considering a new ABS funding facility that would help to jump start the moribund ABS market for consumer loans.
Most important, using available funds to inject capital in exchange for preferred shares, and creating a mechanism – a “good-bank-bad bank” structure – to ring-fence some troubled assets would buy time to assess NPLs, promote appropriate writedowns, and encourage significant further consolidation in financial services. In turn, cleaning up balance sheets, as was ultimately done in Sweden in their 1992 banking crisis, in Japan, and in the US savings and loan crisis, will help slow the deleveraging process and ultimately is the only way to end the credit crunch. To quote my colleague Robert Feldman in drawing conclusions from the Japanese crisis: “Capital injections are a necessary but not sufficient condition to restore confidence in bank equity prices. Confidence needs to be restored in the value of the assets before stocks undergo a sustainable increase. This can only be achieved by removing bad assets from the balance sheets, without recourse.” I couldn't agree more. It is encouraging that the Fed and the Treasury are using such a structure – not just to help ailing Citigroup, but also to reduce systemic risk (see Betsy Graseck, Citigroup: Fed Action a Strong Positive; Less Loss and Dilution Risk, November 24, 2008).
The second needed set of policies includes aggressive implementation of steps to mitigate mortgage foreclosures. The rising tide of foreclosures adds to the inventory of vacant homes and to the real estate owned on lenders’ balance sheets, puts downward pressure on home prices, and creates significant economic hardship for the individuals, the lenders, and the communities involved. There are many obstacles. Not all foreclosures should or can be avoided; the goal is to reduce preventable foreclosures. Forbearance in some cases may simply delay default and encourage irresponsible behavior. The government can’t influence all mortgages, and making loan workouts work will cost some money. There is a risk that any remedy to fix a temporary crisis will become permanent. Given those obstacles, there are no good choices, but the least bad ones would be targeted, varied, and would share losses among borrowers, lenders and the taxpayer. The FDIC proposal, modeled after the protocol used for IndyMac Bank, shares the losses 50-50% between the lender and the agency in the event that modified loans re-default; the plan for Citigroup requires use of this plan. These measures will complement steps to clean up balance sheets and help troubled homeowners.
Finally, officials should seek policies to reduce the supply-demand imbalance in housing. Here there is debate over the most effective policy options. New tax subsidies, as proposed by Alan Meltzer, would increase housing demand, but they risk becoming permanent. And in the context of a serious credit crunch, they may not be sufficient to push up housing demand. It’s worth noting that the benefits for housing demand from lower mortgage interest rates and increased credit availability from steps 1 & 2 above should also help. In other words, these three steps should be implemented in concert as part of a complete package.
.... And my colleague Abhijit Chakrabortti notes that the S&P 500 dividend yield at 4% is 150 basis points above its long-term average.
...
http://www.morganstanley.com/views/gef/index.html#anchor7232
